His query made me think. I evaluated various options available for youngsters like him who wish to accumulate fund for the long-term and wish to save tax as well. The first thing which came to my mind was Equity Linked Savings Scheme (ELSS) which entitles you to avail tax benefits under Section 80 C of up to Rs 1.50 lakh besides offering an excellent opportunity for capital appreciation in the long-term. Let us discuss in detail.
So how big would be this sum?
The average returns generated by Sensex over a period of 40 years between 1979, its base year, to 2019 is approximately 16%. Sensex could generate these returns despite the Harshad Mehta and Ketan Parekh scams. It has also been able to absorb the turmoil caused from time to time due to global credit crisis, oil and other country specific crisis. The return calculated above does not take into account the dividends which the Sensex companies have given over the above period. As of today, the yield on Sensex scrip is around 1.21%.
One product which allows you to save tax and reap the benefits of equity return is ELSS.
So presuming you start investing Rs 1,00,000 in a good ELSS each year, during 35 years of your employment tenure and presuming it generates 16% returns, you will be able to accumulate Rs 13 crore at the time of your retirement. It is presumed that you start your career at the age of 25 and retire at 60 after having put in 35 years of service. The above calculation is done without taking account the income tax, which you would be able to save by contributing to ELSS.
Currently, the Long-Term Capital Gains (LTCG) on equity oriented schemes like ELSS are tax free up to Rs 1 lakh each year and beyond which it is taxed at flat rate of 10%. The tax rates and provisions keep on changing. It is not possible to predict the tax regime for ELSS which is likely to be prevalent at the time of your retirement. I have ignored the taxation aspect while arriving at the corpus numbers. If one were to take the tax of 10% into account, the net corpus would come down to Rs 11.70 crore.
There is no entry load on purchase of units of mutual funds and also there is no transaction cost involved in investing in ELSS. However, it is pertinent to note that the AMCs charge fund management charges, which average around 1.50% of the asset under management. Since we have not taken into account the dividend yield of Sensex listed companies, I think the dividend yield will take care of fund management charges for our calculation arrived above.
How to go about it
Investing lump sum amount in any equity linked product like ELSS is not advisable as the equity market is volatile. So you should stagger your investment and invest in the ELSS through Systematic Investment Plan each month so that the effect of the volatility is minimized.
Lock in period for investments made in ELSS
The investments made by you in ELSS have a lock in period of 3 years so you cannot redeem your ELSS investments for three years. In case, you have invested in ELSS through SIP each investment of SIP will be treated as a separate investment and each SIP has to complete the period of three years. Since Long Term Capital Gains (LTCG) on ELSS are tax free up to Rs 1 lakh each year, you should redeem your investment in ELSS up to the amount of investments which gets you benefit of Rs 1 lakh tax free LTCG.
Since there are no major transactions costs in ELSS, you can recycle your existing investments which have completed the lock in period of three years to avail the benefit of 80C deduction without actually sparing any money in case you are facing liquidity crisis. This will ensure that your are able to avail the benefit of tax free income of Rs 1 lakh and avail the tax benefits without investing any money.
So what are you waiting for?